In Asia, who benefits and loses the most from falling oil prices?

The falling oil price was one of the most dramatic developments of 2014; which transformed the geo-political and economic landscape of every country. From $115/barrel in June, the prices of oil plummeted by more than 60 per cent to around $45/barrel at present. Oil prices peaked at a historical high of $145/barrel in 2008 and crashed to $40/barrel within the same year due to the US subprime credit crisis. Perhaps, the price hike was caused by surging demands from China and India. It was important for the oil prices to fall to ensure sustainable global growth but why did it happen so fast? The problem is rooted to the advent of shale oil in the United States and Canada and a resultant glut in oil supply which disrupted the fundamental equality between supply and demand. Incremental production from OPEC and non-OPEC countries, a rising dollar against a range of currencies and easing global demand further undermined the price of oil. The surplus oil led to declining oil prices and exaggerated the competition between the US and the GCC stakeholders. In order to stay abreast, oil prices have declined globally and are expected to usher in an impending economic crisis. The tremors of such sudden and sharp price movements are having varied impacts across Asia because Asia hosts both the world’s largest oil exporters as well as oil importers. In order to identify who benefits and loses the most from the falling oil prices, it is imperative to understand the key operating factors and foresee some possible developments that may improve or further worsen the situation at hand.

Saudi Arabia, one of the world’s largest oil exporters, can support oil prices by cutting back on its production. But the government is adamant on retaining its market share and has refused to reduce its throughput to prop up oil prices. They have amassed plenty of reserves during the years of high oil prices and purportedly, have enough to tide over the current declining trend. These reserves, which were filled with oil-generated money, are testimony to Saudi Arabia’s oil production efficiency, which results in the cost of production to be as low as $30-35/barrel. For many, this sounds too good to be true and since these reserves are non-audited, it further strengthens their argument. Although, the Saudi Arabian revenue is impacted by low oil prices due to the volume of production, Saudi Arabia is aiming to ensure an operating margin, which may just not be as significant as during higher oil prices but existent, nonetheless. The impact of declining oil prices is substantially more severe on the entirely oil-dependent economies of Russia, Iran and Venezuela.

OPEC members have disproportionate strengths over the battle for oil. Like Saudi Arabia, the United Arab Emirates and Kuwait have stockpiled considerable foreign currency reserves, which implies that they can withstand the deficits for years to come, if need be. Conversely, the impact on countries like Iran is more profound owing to its larger population size and therefore, greater domestic budgetary demands. The condition is worsened by the EU embargo and US sanctions on Iran’s nuclear program, which has led to a sharp fall in Iranian oil exports. The loss of oil revenue, which accounts for a half of government expenditures, and isolation from the international banking system, has caused Iran's currency, the Rial, to lose substantially against the US dollar and caused inflation to rise to more than 40%, with prices of essential foodstuffs and fuels soaring. As the budgetary expenditure escalates, the breakeven point follows, resulting in a fiscal deficit, which may require Iran to cut back on their capital expenditures. In fact, if the budget deficit increases beyond a certain limit, the government may even need to slash current expenditures, which coupled with intrinsic social unrest is likely to be extremely injurious socially, politically and economically. In fact, this manipulation of oil prices is largely driven by sectarian and political agenda surrounding the Shia-Sunni rivalry. Saudi is looking to establish geo-political dominance by overthrowing Syria’s Assad, a Shiite ally of Iran and impeding its Islamic rival’s goal of creating a Shiite crescent. Thus, it is a Saudi strategy to go after Russia, the main backer of its opponent, Shiite Iran by adversely impacting its economy. While Russia still has the reserves to weather a bad year by making necessary budget cuts, Iran has to choose between forging its nuclear program and facing international austerity versus opening up to the world economy, which means more Iranian oil, a further plunge in prices, bad news for the US but definitely light at the end of the tunnel for Iran.

The demand side of the story is more positive as consumers in oil-importing nations are paying lesser to drive their cars and heat their homes. China, the world’s second largest net importer of oil, is stockpiling its oil reserves but is challenged by slow economic growth. In any case, China is a manufacturing giant and the world’s largest exporter. And with extremely competitive export prices, foreign investment and the standard of living will continue uphill. Cheaper oil is expected to replace dirty fuels, clean up the Chinese air and support government initiatives to cut down on subsidies. But the situation in China is approaching a bottleneck in that China’s tanking capacity is running out and international stakeholders are demanding quantification of China’s oil reserves. Its neighboring powerhouse, India, is reaping greater benefits because India imports 75% of its oil and cheaper oil implies shrinkage of the account deficit and more freedom for discretionary spending. As an agricultural economy, energy inputs into fertilizers and water pumping activities are achieved at lower prices and because exports largely exceed imports, the savings from reduced subsidies can ease the account deficits. Also, cheaper energy moderates inflation and lowers interest rates, inviting foreign investment. In fact, the new Indo-US partnership to ‘Make in India’ has already touched a chord in the minds of investors.

In other countries like Malaysia and Indonesia, governments have gone on to reduce or completely abolish fuel subsidies in order to re-fill their coffers and place them on a more even keel. In Japan, falling oil prices have mixed implications. Japan imports almost all of the oil it uses and in that sense, is a beneficiary of cheaper oil. But higher oil prices meant that Japan was finally moving out of deflation but lower oil prices have nullified Abenomics i.e. the government’s strategy to achieve inflation. Unfortunately, Japan is likely to remain in deflation till either domestic demand grows or oil prices surge. But lower inflation rates have positively impacted Philippines, where a drop in interest rates is advantageous for foreign investment. And as an indirect advantage of lower energy efficiency, Philippines have a greater demand relative to its population.

It is quite apparent that lowering of oil prices is a blessing for oil-importing nations while a time of fiscal tightening for oil exporters. This sudden fall in oil prices has definitely helped reduce energy subsidies in the oil importing countries and focus on economic diversification in the oil exporting countries. The price play by various producers could result in one, shale oil activity loosing stream due to increasing economic non-viability and two, countries like Iran and Russia losing market share. In the entire scheme of things, producers like Saudi Arabia, UAE, Qatar and Kuwait, who have a lower cost of production stand to gain while shale oil production and other producers with higher production costs are bound to loose out. The skies seem particularly cloudy for Iran, which appears to be the biggest loser in Asia and its course of action will singularly have a major impact on the global trends of 2015. On the other hand, India seems to have benefited ‘the most’ from these trends due to relatively faster economic growth centered about agriculture, diminishing deficits and most importantly, the rather enthusiastic and encouraging wave of foreign investments that have followed Narendra Modi. In the short run, low oil prices will improve the profit margins of refineries and petrochemical plants as it will take time for the final products’ pricing to fall to the extent when refining margins get squeezed. And oil prices could increase in the second half of 2015 albeit gradually but over a longer horizon, oil prices will fall due to increasing competition from renewable energy; which again will result in a rearrangement of geo-political influences. At this juncture, hope oil gets well soon and may the economics be ever in favor!